#NotEnough: How to fix the Good, the Bad and the Ugly in Indian PSU banking landscape

The results of the banking sector in the third quarter (October-December 2015) have, as expected, revealed a flotilla of public sector banks floundering on a sea of red ink. Collectively, they have lost Rs 10,727 crore, even while their private sector counterparts reported almost an equal level of profits, around Rs 11,218 crore.

Gross non-performing assets of public sector banks are just under Rs 4 lakh crore

More horrendous is the level of bad loans they are staggering under. The gross non-performing assets (NPAs) of public sector banks are just under Rs 4 lakh crore, and they collectively account for 90 percent of such rotten apples in the country’s banking portfolio.

In terms of net NPAs, their share is even higher – at 92 percent of the total bad loans reported so far in the banking system. And since we can expect more bad news in the next quarter, when the Reserve Bank has asked banks to disclose the real story of their bad and stressed assets, we are really talking about a sick banking sector.

Sick does not mean there is no remedy. But remedies call for bitter medicine, and this depends on whether the patient will be willing to swallow it. Dr Raghuram Rajan may have helped with the diagnosis by refusing to let banks hide the symptoms, but the persons in charge of the patients, Mr N Modi and Mr A Jaitley, have to accept the prescription and do something about it.

To be sure, Dr Rajan has not actually prescribed any medicine beyond asking banks to admit they have a serious problem on their hands. But remedies are easily available in the over-the-counter non-prescription market, and these include privatisation, closure or merger.

If privatisation is not on due to legislative hurdles, at the very least management autonomy and privatisation of management must be attempted. Once that is done, the rehab plan can include giving the patient health supplements like additional capital and equity. Some patients should, however, be given over to surgery and euthanasia.

Broadly speaking, the NDA government needs to follow a tough rule-of-thumb while deciding what to do with the open wounds Dr Rajan has left it to attend to.

First, there is no point wasting capital on banks that are fundamentally stretcher cases. Any bank which has net NPA proportions above 5 percent must be sent for critical care, or euthanasia. The banks in this category include Indian Overseas Bank (8.32 percent), Uco Bank (6.51 percent), United Bank of India (5.91 percent), Dena Bank (6,68 percent), Bank of Maharashtra (5.52 percent), Central Bank (5.3 percent), and two biggies – Bank of Baroda (5.67 percent), and Bank of India (5.25 percent). It is net NPAs which matter, since gross NPAs include bad loans on which provisions have already been made and thus can’t cause further damage.

The first six need to be merged, closed or forced to become narrow banks – where they cannot lend sums beyond a limit till their NPAs come down. These banks should be starved of capital and forced to become competitive or merge with stronger banks.

As for Bank of Baroda and Bank of India, they are both among the Big 5 public sector banks, and they are too big to merge or abandon. BoB under private sector CEO PS Jayakumar has indicated that the worst is over for it, having taken the bad loans hit fully in the third quarter.

The CEO also says he does not need further capital, and one can assume that the bank only needs close monitoring in the coming quarters. Bank of India, on the other hand, needs to be capitalised more strongly, which means the government must subscribe to the additional capital and make sure it has a competent management team in place to pull itself up by the bootstraps.

Second, even the so-called stronger banks – State Bank, among them – are not that strong. With gross NPAs at a massive level of Rs 72,792 crore, the sheer volume of rotten apples in SBI’s basket is huge and capable of contaminating others; its net NPA basket harbours Rs 40,249 crore, enough to sink most private sector banks.

SBI is not vulnerable only because it is the one bank which has a tacit 100 percent sovereign guarantee. No government can afford to let SBI get into trouble in terms of depositor confidence. In fact, this is broadly true of most of the bigger public sector banks.

Which is why fixing these banks is even more important than addressing the issues of sickly losers like Indian Overseas Bank, Uco Bank and Dena bank. The big banks are broadly proxy for the economy (these include SBI, BoB, Punjab National, Bank of India, and Canara Bank, apart from the private sector ICICI Bank and HDFC Bank).

If they are looking unhealthy, it means the economy is itself unhealthy, and incapable of recovering too soon. Also, fixing strong banks will have better payoffs than supporting weak banks. The law of the jungle says it is the strong which must survive, not the weak.

Logically, the big banks must be encouraged to revalue their undervalued assets, and sell off their non-core subsidiaries. The State Bank, for example, should be able to raise money by diluting stakes in some of its bank subsidiaries, not to speak of its insurance arm, SBI Life. Its real estate should also be monetised.

For those without the ability to raise capital internally through asset sales, the government will have to provide the capital, but this should be given with the strict understanding that future capital for expansion should be generated internally.

Third, the worst performers in the banking sector should be declared as bad banks – and all other banks capable of reviving should be asked to unload their bad assets at discounted prices with these bank. As things stand now, Indian Overseas Bank – whose balance-sheet is more undersea than overseas, qualifies as the ideal candidate for becoming the first bad bank. Uco Bank is another. These two banks should sell their liabilities (deposits) and assets (good loans) to the banks that seem worth reviving, and be asked to chase bad loans with a vengeance.

A bad bank should not be the place to dump bad employees. In fact, bad banks need the best and the brightest from the private sector to focus all their efforts on collecting unpaid dues from the recalcitrant, and, if needed, force the closure of units that are technically bankrupt. Modi must put his A Team of bankers to head bad banks.

Fourth, none of this can work without the government legislating the bankruptcy code, which is currently being vetted by a joint committee of parliament. It is best to get this legislation done in the budget session of parliament, so that by mid-April, the bad banks can get going.

Speed is of the essence. Even though the banking crisis is a legacy of the UPA, the NDA compounded it by failing to realise the seriousness of the problem in its first year in office. Indradhanush, the plan to slowly recapitalise banks, has been overtaken by events.

The market crash has ensured that the entire valuation of the public sector banking industry does not equal even that of HDFC Bank (currently valued at Rs 2,44,000 crore). The government’s capital contribution to the worthy must be raised quicker and in larger dollops as the rot is spread deep in public sector banking. Surgery is vital, as Dr Rajan noted the other day.